A Little Light in the Dark Corridors of Power

November 26, 2013

Jeff Faux

The deeper you are in the inner sanctums of power, the slower you are to get disturbing news from the rest of the world. So, I suppose it should be no surprise that it has taken so long for a prominent member of the American policy elite to suggest openly to his colleagues that the core assumption upon which they have been managing the economic crisis might be dead wrong.

Four and a half years after the current “recovery” began, economic pain remains widespread. Wages and incomes are still falling, the share of jobless working age people has not declined, and hunger and homelessness are rising.

Yet the Washington/Wall Street message to the rest of America remains: Have patience.

True, acknowledges the official story, we’re in the slowest recovery since the 1930s. But capitalist markets always fluctuate around a long-term trend of expansion at full employment. It follows that what goes down must come up. So, after previously assuring us that a deep recession would mean a strong recovery, they now tell us the deep recession is the reason for the weak one. Anyway, the accepted wisdom continues; as long as the Federal Reserve keeps the cost of capital (i.e., interest rates) low, sooner or later the natural workings of the market will returns us to pre-2008 prosperity.

Thus, the leaders of both parties agree that over the next decade, government spending must be slashed further (e.g., the Democratic Senate wants to cut food stamps by $4.5 billion, the Republican House by $39 billion), implicitly assuming that the private sector will by itself will produce full employment and rising real incomes.

Now comes Larry Summers — one of the chief designers of the policies that led to our current economic morass — suggesting in a November 8 speech to the International Monetary Fund that this fundamental assumption does not square with observed reality.

Summers was uncharacteristically cautious (“Now this may all be madness, and I may not have this right at all”), but nevertheless clear. He thinks we may be in a version of what John Maynard Keynes called a “liquidity trap” — a condition in which the economy is stuck below full employment because consumers are not spending and therefore businesses are not investing. Under these circumstances, keeping interest rates low is not enough to bring us back to the long-term growth trend because the problem is insufficient demand, not the price of money. Indeed, Summers thinks that the interest rate needed to re-stimulate business has gone as low as it can.

Although his prescription is unclear, Summers’ now seems to agree with the economic diagnosis of Paul Krugman, Joe Stiglitz and others of us who have been arguing for government to break us out of the trap by borrowing and spending more in order to create new jobs, profitable investments and rising income. Once we are back to full employment, our story goes, we can raise taxes and or cut back spending to reduce the deficit.

But Summers also said something else, which has not been widely discussed, even among progressive economists. He noted that the impact of the financial asset and housing boom that preceded the bust of the fall of 2008 was in fact not all that great. Unemployment was not extraordinarily low, capacity wasn’t strained and there were hardly any signs of inflation. “Somehow,” he observed, ” even a great bubble wasn’t enough to produce any excess in aggregate demand.” He concluded that it might be time to resurrect the old idea (held by both Adam Smith and Karl Marx, among others) of capitalism’s tendency toward “secular stagnation”

This was hardly a mea culpa on Summers’ part. And his speech can be construed as a clever defense of his past performance, i.e., that the financial boom he and his Wall Street comrades encouraged was not responsible for the wider economic bust that followed. Nevertheless, he is right that the economy as a whole was really not booming before the financial crash of 2008.

In fact, if you measure the economy’s performance in terms of its ability to generate rising incomes, it has been operating under conditions of secular stagnation since the 1980s, when the gap between worker productivity and median real wages first opened up. According to the conventional explanation (ironically championed by Summers, among many others) depressed wages have nothing to do with a sluggish economy; the problem is that American workers cannot keep up with the educational demands of new technologies. As the Economic Policy Institute has been demonstrating for years, this explanation does not fit the facts. To cite one powerful piece of evidence — the entry wages of college graduates fell during the seven years before the 2008 crash.

As I argued in my 2012 book, The Servant Economy, wage decline is the result of specific policies: free-trade agreements that undermine the wages of American workers; deregulation policies that channel the nation’s investment away from productive sectors into short-term speculation; the relentless corporate attack on workers’ bargaining power.

But for the last three decades, the full depressing effect of lower wages has been softened by three cushions: 1) more women went to work, which bolstered overall family income, 2) cheap credit, which generated a series of financial bubbles and encouraged consumers to buy goods and services they could not otherwise afford, and 3) Federal government deficits.

These cushions have been deflated. More women than men are now in the work force, so that there is little lift left for the economy in sending more family members to work. The after-shock of the great crash has left investors and consumers risk-shy. And Washington is committed to budget cutting.

So how do our leaders think that in the face of these deflated cushions, the private sector will generate the job growth needed to raise wages and incomes? And how long will it take?

The Congressional Budget Office’s annual 10-year economic projection is Washington’s the principal tool for economic policymaking. The CBO’s model does not try to predict recessions; in accord with the reigning ideology, it simply assumes that the economy’s natural tendency is toward full employment. It is therefore perennially optimistic. Each year since the recession began it has forecast full recovery in four years, only to extend the date by a year in its next projection. Thus, in 2010, the CBO predicted full recovery by 2014. In 2011, by 2015. Etc.

The 2013 projection now has us at an unemployment rate of 5.5 percent by 2018 – ten years after the crash. Six years later, 2024, the CBO model bumps joblessness down to 5.3 percent.

How do the CBO forecasters think we will finally crawl our way back? Via a reflation of the housing and financial sector: “An upswing in housing construction (though from a very low level), rising real estate and stock prices, and increasing availability of credit will help to spur a virtuous cycle of faster growth in employment, income, consumer spending, and business investment.” In other words, another bubble. Not only another bubble, but also one that will be so big that it produces the longest economic expansion in our history!

Well, anything is possible. So let’s suspend our judgment and assume the CBO has it right this time. But here is the point: its projected 5.3 percent unemployment rate in 2024 is a shade above the average unemployment rate for the seven years that preceded the crash, and substantially above the 4.4 percent reached in March of 2007. Yet, as Summers has come to understand, even that was not enough to lift wages and incomes out of their secular stagnation. So even if the CBO’s rosiest of scenarios were to come true, ten years from now most Americans would still be having a hard time paying their bills from what they earn — and as a consequence of projected cutbacks, hunger and misery at the bottom of the economic period will continue.

There remains one other possible optimistic scenario: a miraculous and sustained boom in U.S. net exports that would reverse 30 years of trade deficits and suddenly make the US a huge net exporter. Why miraculous? Because such a turnaround would require: 1)

a large, steep drop in the value of the dollar relative to the currencies of our trading partners, who would have to be willing to have their own net exports decline, and 2) a dramatic shift away from so-called free-trade policies in order to channel investment into US produced goods and services. Nowhere in the political landscape are either paths being seriously pursued.

So, the only other non-bubble route to a “recovery” would be a dramatic further cut in US wages – and living standards — that would make America the low-wage producer for domestic as well as foreign markets. Indeed, the evidence tells us that this is Washington’s unspoken default economic policy, even though its depressing effect on consumer spending would be counterproductive. Whether through intention or ignorance, lower wages or another unsustainable bout of speculation are the logical consequence of the bi-partisan commitment to austerity that now rules Washington.

It is difficult to believe that many in Summers’ audience at the IMF do not understand this. But the policy implications — i.e., actually doing something about the trade deficit, the misallocation of capital and the corporate war against workers — are too radical for the financial interests that support their careers. So, in a sense, whatever their predictive value, the standard happy-face economic models serve to protect our cloistered policy intellectuals from having to face unpleasant ideas.

Still, as the economy slouches toward another Thanksgiving in which a majority of American workers report they are in fear of losing their job and food banks and homeless shelters are stretched to the breaking point, I suppose we should be thankful that someone in the power structure is finally willing to say aloud what most Americans already know: our current faith-based polices are not only not working, they will never work.

Recent Stories by Jeff Faux

Four and a half years after the "recovery" began, economic pain remains widespread. Yet the Washington/Wall Street tell Americans, "Have patience." Now, Larry Summers suggests a core economic assumption of the American elite might be dead wrong.

The Democratic Party’s long-term prospects have dramatically improved since the November election. The “Obama Coalition” of minorities and single women is growing faster than the GOP’s white male base. If demography is destiny, Democrats are the wave of the future.